Drewry says liner industry plagued by overcapacity

Friday, June 21, 2013

The container shipping industry will be “plagued by over capacity and the global supply/demand balance will not reach equilibrium until 2016,” said a new report by Drewry Maritime Equity Research.
Drewry made the comment as it initiated coverage on the global container liners’ sector with three major Asian container lines: Orient Overseas (OOIL), Neptune Orient Lines (NOL), and China Shipping Container Lines (CSCL).
Rahul Kapoor, senior analyst at Drewry Maritime Equity Research, said “even as the market awaits the fate of July 1 Asia-Europe general rate increases (GRIs), the sheer collapse in Asia-Europe freight rates in the past two months shows how fickle the industry's demand supply balance remains.”
Just this week, another arm of Drewry said its recently launched Container Freight Rate Website shows average global freight rates fell to a 17-month low in May. The company’s Global Freight Rate Index declined for the fourth consecutive month shedding 9 percent in May.
Kapoor said “short term, industry profitability has become highly volatile, driven not only by underlying supply demand dynamics but increasingly by carriers’ actions with respect to short-term capacity management. Accurate forecasts on a recovery in 2014 are especially difficult since the industry dynamics are highly fluid.
“Peak season is a make or break for 2013 profitability,” he added. “Freight rates have crashed on the key Transpacific and Asia-Europe trde lanes and there are few indications of a favorable demand environment. Carriers have a narrow window of opportunity to get their act together or risk severe losses as they are losing a lot of money at current rate levels.
“With no likelihood of an imminent demand surge, the only way to minimize losses is to address effective capacity immediately, or else any hope of full-year profitability can be written off after a very weak second quarter. Having said that, carriers can still expect to achieve GRI success outside of supply/demand fundamentals, if they were to take a hard-line and aim for profitability,” Kapoor said.
While other arms of London-based Drewry are well known for the research reports and consulting activities, the company has now entered into equity research, focusing on terminal operators and liner shipping companies.
Simon Raper, marketing manager at Drewry, said the company is currently reporting on a dozen terminal companies and will offer coverage on 15 public shipping companies.
Drewry said “its a challenge to find an investable container shipping stock in the current environment. Most companies have seen their cash balances wither and total industry debt has more than doubled in the past five years to $100 billion. Drewry’s analysis of the financial health of the industry paints a grim scenario for the global container liners with financial health under severe strain and shareholder value eroded.
“Most financial indicators point towards a greater need for the industry and in particular the listed carriers to get their house in order before it gets too late. If there is any positive aspect for the wider industry, the current financial pain will limit carriers’ ability to fight purely for market share. Drewry expects to see intermittent market-share campaigns but no single carrier can do it on a sustained basis,” it said.
Drewry Maritime Equity Research’s said its top stock currently is OOIL, the parent company of liner company Orient Overseas Container Line, adding it “ticks all the boxes of a quality company which should be investors’ preferred play in what still is a challenging industry environment.”
It said Hong Kong-based OOIL “remains amongst the few profitable carriers in the industry. Driven by a strong management focus on achieving higher yields and cost optimization, OOIL has delivered sustained profitability and has been consistent in generating higher ROE than its sector peers. OOIL’s financial soundness also negates any balance sheet concerns and liquidity risk in what is expected to be a volatile period for sector profitability.
“OOIL’s valuations are seen as attractive and sustained profitability deserves a premium. Despite the weakness in freight markets and minimal expectations of any upcoming surge, OOIL provides investors with a prudent play on recovery in the container shipping market with lower risk of losses,” Drewry said.
It said it “expects NOL to remain loss making at core levels in FY13 and its weakened balance sheet and high net gearing remain a key concern.”
They say the current valuation for NOL is fair and “the market is not yet ready to assign a premium multiple to NOL, awaiting sustained profitability to emerge.
“However, with global port operators’ investing landscape recently buzzing with heightened investor interests,” it says APL Terminals is “a hidden gem in the company’s asset portfolio. An opportune divestment of terminal assets even while retaining control will potentially unlock and add tremendous value for shareholders.”
Drewry said it accords “fair value in its base case for APL Terminals of $720 million with a high case valuation reaching as much as $1 billion.”
It also noted China Shipping shares “carry an undemanding valuation and are currently trading near the bottom of their recent trading range. They are also now trading at a wide discount to their historical range.”
However, Drewry said it sees the company as a “risky play” and for its core business to remain unprofitable in fiscal year 2013.
“CSCL’s higher-than-industry-average exposure to spot markets in key long haul trades is the real nemesis for the company. In an environment of weak freight markets currently and expected to be volatile over the near term at least, CSCL will underperform most of its peers and thus warrants a cautious view,” Drewry said. - Chris Dupin